The war with Iran is increasingly ceasing to be merely a geopolitical risk and is becoming a real macroeconomic problem for Europe. From a market perspective, this means a higher probability of a stagflation scenario, that is, a combination of weaker economic growth and persistent inflationary pressure. This is a particularly unfavorable mix because it simultaneously weakens economic activity, reduces corporate profitability, and limits the room for response on both the fiscal and monetary policy sides.
Energy-intensive sectors remain the most exposed, especially the chemical industry. Germany, as Europe’s largest industrial economy, is feeling the strain particularly strongly. High energy prices, tensions around the Strait of Hormuz, and the risk of further disruptions in raw material supplies are leading some companies to cut production, which is a clear sign of worsening business conditions. However, this is not a problem limited only to heavy industry. Rising costs of fuel, transport, insurance, and storage are gradually spreading through the entire supply chain, increasing the risk of a broad-based rise in costs across the economy and a further weakening of consumers’ real purchasing power.
From the point of view of economic policy, the situation is becoming increasingly difficult. European governments are beginning to prepare for lower growth forecasts, while central banks may be forced to maintain a more restrictive stance or even tighten monetary policy further if higher energy prices once again feed into core inflation and inflation expectations. This would mean a partial return to the pattern known from previous energy crises: on the one hand, protective measures for households and selected sectors of the economy, and on the other, pressure for higher interest rates. The problem is that many countries today no longer have the same fiscal space they had before.
These budgetary constraints may become one of the most important factors differentiating how individual countries respond. Germany still has relatively greater capacity to support the economy, while many other eurozone countries must take into account high debt levels and tensions surrounding public finances. France’s better-than-expected deficit may give its authorities slightly more flexibility, but it does not change the broader picture. Europe’s fiscal room for maneuver is now clearly more limited than during previous shocks. In practice, this means that every decision to support households and businesses will involve an increasingly difficult choice between economic stabilization and fiscal discipline.
The United Kingdom is also in a particularly vulnerable political position. Rising living costs are already fueling social tensions and populist sentiment, and a prolonged conflict could accelerate that process even further. At the same time, the market is beginning to assume that both the Bank of England and the European Central Bank may be forced into a more hawkish approach if higher energy and transport costs prove persistent. That would mean a further deterioration in financing conditions for households and businesses, placing an additional burden on growth. If the conflict drags on, Europe could enter a period of clearly weaker economic activity while inflation remains above central bank targets.
From a market perspective, this is one of the most challenging scenarios. It implies pressure on corporate margins, greater volatility in bond markets, continued high sensitivity of currencies and equities to energy prices, and growing importance of political decisions. In other words, the war with Iran is becoming for Europe not only a security crisis, but also an energy, inflationary, and fiscal shock that could significantly slow the economic recovery and intensify political tensions in many countries across the region.
